In the land of magical realism, every-day life can be surreal. The rumors and events surrounding the release of the high-value hostages held by the FARC were often hard to believe. Moreover, the timing of the rescue, on the eve of Senator McCain’s visit to Colombia and a constitutional showdown with the Supreme Court, could not have been better. Nevertheless, the end of the Betancourt nightmare and the liberation of the North American hostages was a major victory for Colombia. President Uribe’s popularity soared to 92%, and it looks like he will soon launch a bid for another term in office, but his economic plan may put the country in harm’s way.
Security was the foundation of President Uribe’s economic model, locally known as Uribenomics. The sense of greater security engenders an increase in investment, which in turn propels the level of economic activity. In contrast to most of the other countries in the region, exports were not a priority. The real goal of Uribe’s economic policy was to tap into the pent up demand of 44 million Colombian consumers who were cowering in fear after two and half decades of civil war. The concept worked well. Gross fixed investment soared 20% y/y, pushing the pace of GDP growth to 7.3% y/y in 2008–the highest level in three decades. Foreign direct investment poured in, allowing the peso to appreciate 20% since the start of 2007. Uribenomics functioned as long as international liquidity was abundant. However, the onset of the global credit crunch is taking its toll on Colombia, and the economy could be in for a painful adjustment.
Despite giddy consumer sentiment, industrial production fell 4.3% y/y in May. Retail sales also dropped 0.4% y/y during the same month. In addition to tighter liquidity conditions, higher inflation is squeezing households. Consumer prices spiked 7.2% y/y in June, forcing the central bank to raise interest rates to 9.75%. This forced local analysts to trim their growth forecasts below 5% for 2008. We expect the Colombian economy to grow 4.6% y/y this year, suggesting a significant slowdown during the second semester. After falling for the last 7 years, and bottoming out at 9.9%, the unemployment rate is rising—reaching 11.8% in June. Local analysts are expecting consumer prices to rise 6.5% y/y in 2008. However, our projections show that this year’s inflation rate could top 8% y/y. Nevertheless, the biggest surprise will be in the fiscal accounts. The spike in oil prices was a tremendous boost for the government, since it had such a positive effect on royalties. The consolidated fiscal deficit fell to 1.3% of GDP, against a projected shortfall of 2% of GDP. Unfortunately, the slowdown in the global economy marked the end of the oil rally, and crude prices are falling. This will be bad news for the fiscal accounts, and it will put more stress on the balance of payments, thus marking the end for the country’s investment grade aspirations.
President Uribe is well aware of the dangers facing the Colombian economy, and he recently announced measures to confront the deterioration of external conditions. In addition to a reduction in government spending, the president announced new measures to attract more foreign investment. However, the point may be moot. Confidence is not the problem. The real problem is that capital is scarce and dear. The economic woes could soon spell trouble for Colombian financial institutions. Banks went on a lending binge during the last two years. Credit for homes, automobiles and durable goods was abundant. However, tighter monetary policy and reduced access to external lines of credit could leave the banks scrambling. This is the moment when Colombia may have wished to have had more emphasis on exports and trade. Unlike the other countries in the region, which could see the adjustment focus on the external sector, Colombia will be forced to take the entire adjustment on its domestic demand. The shortfalls of Uribenomics could make President Uribe’s third term in office a less memorable affair.